The 3 Steps To Destroy Wealth During Market Volatility

If you’ve recently turned on the news to see the stock market dropping, you may have felt a sudden spike in blood pressure and an urge to act. In the last few months, the market has wobbled like a punching bag to a barrage of negativity, including Federal Reserve interest rate hikes, new tariffs on China, a Facebook data leak and the constant specter of the next Trump tweet. After hovering near all-time lows, market volatility (as measured by the Cboe VIX Index) began to spike as the near decade-long bull market finally showed signs of fatigue.

Cboe VIX Index.Data source: Cboe.

In times of resurging volatility like this, we feel such gut-wrenching emotions for the same reason we feel anxious as passengers on a plane but not as drivers of a car. We cast aside logic (air travel is far safer than car travel) because we biologically require control. And when we feel like things are taking a turn for the worse, we impulsively want to steer away from danger. Unfortunately, these instinctual reactions often cause serious damage to our financial security. As volatility continues, investors who react to headlines, focus on forecasts and abandon long-term plans can most efficiently destroy wealth.

React To Headlines

After almost a decade of stock market growth and relatively low volatility, investors had grown accustomed to the comfort of a Dow that regularly set record highs. So on recent down days, some investors have likely started to sweat through flashbacks of 2008. Meanwhile, the news reinforces our all-to-human emotional need to respond by splashing hyperbolic headlines across our screens. For the sake of a ratings bump, the media uses scare tactics that lead average investors to think that a single-day market drop signals the next global financial crisis.

Now more than ever, investors face both information overload and easy access to technologies that help us make our instinct-based bad decisions. Retirees, for example, can watch red flashes on CNBC and subsequently sell investments with the touch of a button on an iPad. On a day in early February, headlines gleefully announced that the Dow had suffered “the biggest single-day point drop in history.” Enough investors responded by logging into online accounts to sell that several investment websites crashed. Ironically, this systems failure saved investors from themselves as markets proceeded to rally over the next several weeks.

Focus On Forecasts

On top of our urge to act when things get scary, we’re always cautious of what’s to come, needing to know what lurks around the corner so we can make the first move. So rather than finding comfort in a long-term investment plan, many investors spend their days anxiously over-analyzing any data points that might move markets, from jobs reports to Trump tweets. Meanwhile, even expert economists could all look at the same data and tell completely contradictory stories about the future of the economy.

Investors who focus on forecasts inevitably attempt to take advantage of perceived opportunities or to avoid perceived threats. Instead, these investors more often lock in significant losses after the market has dropped and miss out on gains during subsequent up days. After the market has moved higher, those investors buy back into markets too late, thereby missing the upward correction and instead locking a loss at the bottom and paying a premium at the top.

Dow Jones Industrial Average (2018).Data source: Yahoo Finance.

Abandon The Long-Term Plan

While a sound, long-term investment strategy shouldn’t shift because of single-day ups and downs, our emotions in volatile times too often tell us otherwise. Suddenly, average investors become day traders and begin to methodically chip away at long-term financial security. While it’s hard to stick to stoicism in the face of fear, try to remember how panic forced long-term investors to sell at losses during the Great Recession. If they had chosen instead to stick to the long-term plan, their portfolios likely would have grown substantially over the last decade.

While we shouldn’t feel guilty for the human emotions we’re programmed to feel, we need to recognize that emotion-based investment decisions prove far more detrimental to financial success than short-term market drops. Ultimately, a long-term, diversified portfolio needs to match an investor’s liquidity needs, goals, time horizon and risk tolerance. While other investors follow the all-to-familiar steps to destroy wealth during volatility, long-term investors with proper allocations can brush off the hyperbolic headlines, forget about forecasts and stick to the long-term plan.

I’m a financial advisor and managing director at Conway Wealth Group, a private advisory firm based in Parsippany, NJ. I write about creating balance between life and money. On the job, I help clients live a Life Beyond the Numbers™ by focusing not just on investment gains, ...